How will the ‘Grand Coalition’ affect the Euro?

A very sleepy session to the start of
the week in FX as Japan’s markets are closed for a holiday and US celebrates
Columbus Day with Banks and Fixed Income markets closed here as well.

In Germany, Angela Merkel and Gerhard Schroeder have finally
settled their differences with Mrs. Merkel taking the helm of the Chancellorship
and Mr. Schroeder stepping down from all governmental posts. The coalition
government will have an equal number of CDU and SDU Cabinet members with the
Socialists holding the foreign ministry post and Mr. Stoiber expected to become
the next finance minister. The news provided a mild boost to the euro as the
political uncertainty surrounding Germany for the past three weeks appears to
have been resolved.

The market, however, is skeptical about the effectiveness of
the “grand coalition” government and the euro is unlikely to receive any long
term benefit from this outcome until both parties can demonstrate to the world
that they will set aside their partisan differences and will legislate in a
businesslike manner. We are actually more optimistic than the consensus view
about the possibility of coalition rule. Germany is clearly in need of serious
restructuring and with neither the far right nor the far left able to sabotage
the reform agenda, the two mainstream parties may just be able to create a
workable plan of action.

On the economic front, the German Trade Balance reported a bit
softer at 11.6 Billion euros vs. 12 Billion expected, but the shortfall wasn’t
for lack of export growth which increased by a substantial 3.5%. Rather, the
record energy prices of the past month helped to push Imports up to a whopping
6% month over month gain.

Energy costs also played havoc with UK inflation numbers, as
UK Output PPI rose for the third straight month jumping to 3.3% annual level.
The BOE is now caught between a rock and a hard place since it is unable to
lower rates to stimulate lagging consumer demand for fear of exacerbating
inflation. With UK economy generally leading the US economy by six months, we
fear the exact same dynamic may face the dollar. Over the week-end Fedex
announced 5.5% rate increases, the highest in nine years, an action that is
likely to reverberate throughout the US economy and only turn the Fed more
adamant in its rate hike policy. All of this tightening is likely to cap any
further appreciation in housing and it turn make the US consumer even more
gloomy as we approach the Christmas season.


Boris Schlossberg serves as Senior Currency
Strategist with Forex Capital Markets in New York, the largest retail forex
market maker in the world. He is a monthly contributor to SFO Magazine with
articles focused on understanding proper risk management, trader psychology and
true market structure. He is also a featured expert at and a frequent
commentator for the Marketwatch From Dow Jones Currency and Bond Report